For an industry that is meant to be forward looking and agile, it is surprising how the fund management community have allowed themselves to stay a couple of steps behind the companies that they buy and sell.
UK fund managers have traditionally structured themselves along geographic lines. This means that separate teams would be responsible for the management of UK, US, continental European, Japanese, Far Eastern and emerging market stocks. The teams would operate in isolation from each other, employ different research and valuation techniques, and possibly be subject to separate management structures. In effect, these silos were separate fund management organisations that happened to be owned by the same parent!
The status quo in the US is quite similar, but there the main dividing line is the American border. Typically, US fund managers have US equity and international equity teams. In this context, international means the non-American world. Here too, the teams operate in isolation and are effectively separate organisations.
Under this system, the term ‘global equity brief’ is really a misnomer, as the fund manager farms out regional portfolios to separate teams. They are, in fact, a collection of regional specialist briefs that happen to run by the same organisation, and it is not surprising that better results would probably have been achieved by picking the best of breed in each region. This needs to be borne in mind when looking at historic performance figures for global equity and regional equity portfolios.
It is quite bizarre that silo management has persisted for this long as the dominant model amongst UK investment houses. But change is underway and there appears to be a genuine momentum behind moves to embrace a more global approach to equity management.

Lessons from 2000
In 2000, the average UK fund manager under performed the FTSE All-Share Index by 2.4%. The often quoted reason for this failure to add value is that the market was driven by a small number of large companies. As a point of fact this is true, but why did the fund managers get these stocks wrong? Many managers now acknowledge that they failed to take account of the international investor and the extent to which large UK companies, which also happen to be multinationals, were seen to be attractive in the context of US stock valuations.
A good example is British Telecom. By and large, UK fund managers regarded BT as a boring utility, with low growth prospects and a steady income stream. The US fund managers, on the other hand, began sizing up BT as a tech stock, and the company was repriced on this basis. UK institutional fund managers were generally underweight and their performance suffered, certainly in the run up to 2000.
With the benefit of hindsight, perhaps the UK managers’ assessment of BT’s prospects was correct, and had their view prevailed, perhaps the company would not have been encouraged to embark on the profligate expansion that lead to its debt crisis. However, whilst elements of the tech boom can now be dismissed as a temporary bubble, the fact that UK companies are increasingly priced in a global context cannot be ignored. Quite simply, UK fund managers have realised that in order to run a UK equity portfolio, they need to be thinking within a global context.

A second factor is the growing realisation that a stock’s country of listing may not be the most relevant way to classify the company for the purposes of analysis and fund management. The spate of global mega-mergers (BP/Amoco, Vodafone/Airtouch/Mannessman, Astra/Zeneca etc) over the last few years has made it very clear that companies will ‘choose’ to be listed on one exchange rather than another for a variety of reasons, that may have very little to do with their underlying business. The large number of South African companies that have chosen to move their primary listing to London highlights the point that regional groupings lead to an increasingly arbitrary collection of stocks. The FTSE Multinationals Index took this argument further by identifying a group of large multinational companies that would be arbitrarily placed in any one country’s equity index.
It has been fascinating working with fund managers to see how they would run a portfolio against the Multinationals Index, and it has been clear that they have generally been extremely challenged by the concept. Interestingly, the main barrier is not the particular make up of the Multinationals Index, but the seemingly simple task of being able to compare similar companies that happen to be listed on different exchanges. Most UK fund managers have no mechanism for comparing Exxon with BP Amoco, and that has nothing to do with the index they have been asked to beat.
To lend further support for this trend, various academics studies have pointed at the rising correlations between regional index returns. There is now a reasonable body of evidence to suggest that the global industry a stock belongs to is more important than the country in which it is listed. This evidence is very strong for Euroland and it is not surprising that fund managers now largely ignore the country of listing within Euroland.

Client demand
Trustees are often accused of moving at a glacial pace, but in this area, it has been the pension funds, rather than the fund managers, that have really brought the energy for a change. Most trustees had become concerned with the concentration within their UK equity portfolios, and the fact that the large UK stocks represented a greater portion of their assets than the exposure to the entire US market. Trustees reacted by decreasing their UK equity weighting and this raised a number of questions about the management of the larger overseas portfolio. Who should manage the brief? How should they be benchmarked? Trustees have generally adopted a far more international perspective to their thinking over the past few years and this has forced the fund managers to follow suit.

Where are we going now?
After two years of quite substantial reorganisation of the equity portfolio, we are still in a transitional phase. Almost all fund managers have set up global research teams, but the scope and extent of these teams differs quite substantially from firm to firm. In some cases, the old silos still operate, but now talk to each other. At the other extreme, the structure has genuinely altered to facilitate global industry stock picking. Most fund managers lie somewhere in the middle.

The new mantra?
Mantra’s are usually dangerous and new mantra’s can be just as destructive as the ones they replace.
It has become clear that UK fund managers had allowed themselves to get behind the pace of globalisation and had failed to adjust their structures to take account of how large companies actually behave. However, globalisation is today’s fashion. And as with many fashions there is substance and form and the challenge for all of us in the industry is to distinguish between the two. Certain industries are very global and the country of listing is about as relevant as the first letter in the companies name. Other industries are less global and regional factors are still very important.
It would be a great shame if fund managers that continue to adopt regional structures are dismissed simply because they do not conform to the new fashion. But, going forward, the starting assumption is likely to be with the global industry approach and the burden of proof is likely to fall on those managers that continue with the regional approach.
Kerrin Rosenberg is a partner with Bacon
& Woodrow in London